Conventional wisdom used to dictate Australians were better paying off their home loans, and then, once debt-free turning their attention to building up their super. But with interest rates ramping up over the past two years, and uncertainty as to when they are likely to reduce, what’s the right strategy in the current market?
It’s one of the most common questions financial advisers get. Are clients better off putting extra money into superannuation or the mortgage? Which strategy will leave them better off over time? In the super versus mortgage debate, no two people will get the same answer – but there are some rules of thumb you can follow to work out what’s right for you.
One thing to consider is the interest rate on your home loan, in comparison to the rate of return on your super fund. As banks ramped up interest rates following the RBA hikes over the past two years, you may find that the gap between home loan interest rates and the returns you get in your super fund has potentially shrunk in comparison.
Super is also built on compounding interest. A dollar invested in super today may significantly grow overtime. Keep in mind that the return you receive from your super fund in the current market may be different to returns you receive in the future. Markets go up and down and without a crystal ball, it’s impossible to accurately predict how much money you’ll make on your investment.
Each dollar going into the mortgage is from ‘after-tax’ dollars, whereas contributions into super can be made in ‘pre-tax’ dollars. For many Australians, saving into super will reduce their overall tax bill – remembering that pre-tax contributions are capped at $30,000 from 1 July 2024 and taxed at 15% by the government (30% if you earn over $200,000) when they enter the fund.
So, with all that in mind, how does it stack up against paying off your home loan? There are a couple of things you need to weigh up.
Consider the size of your loan and how long you have left to pay it off
A dollar saved into your mortgage right at the beginning of a 30-year loan will have a much greater impact than a dollar saved right at the end.
The interest on a home loan is calculated daily
The more you pay off early, the less interest you pay overtime. In a higher interest rate environment many homeowners, particularly those who bought a home some time ago on a variable rate, will now be paying much more each month for their home loan.
Offset or redraw facility
If you have an offset or redraw facility attached to your mortgage you can also access extra savings at call if you need them. This is different to super where you can’t touch your earnings until preservation age or certain conditions of release are met.
Don’t discount the ‘emotional’ aspect here as well. Many individuals may prefer to paying off their home sooner rather than later and welcome peace of mind that comes with clearing this debt. Only then will they feel comfortable in adding to their super.
Before deciding, it’s also important to weigh up your stage in life, particularly your age and your appetite for risk.
Whatever strategy you choose, you’ll need to regularly review your options if you’re making regular voluntary super contributions or extra mortgage repayments. As bank interest rates move and markets fluctuate, the strategy you choose today may be different from the one that is right for you in the future.
Case study where investing in super may be the best strategy
Barry is 55, single and earns $90,000 pa. He currently has a mortgage of $200,000 which he wants to pay off before he retires in 10 years’ time at the age of 65. His current mortgage is as follows:
| Mortgage | $200,000 |
| Interest Rate | 6.80% pa |
| Term of home loan remaining | 20 years |
| Monthly repayment (post tax) | $1,526.68 per month |
Barry has spare net income and is considering whether to:
- Make additional/extra repayments to his home mortgage (in post-tax dollars) to repay his mortgage in 10 years, or
- Invest the pre-tax equivalent into superannuation as salary sacrifice and use the super proceeds at retirement to pay off the mortgage
Assuming the loan interest rate remains the same for the 10-year period, Barry will need to pay an extra $755 per month post-tax to clear the mortgage at age 65.
Alternatively, Barry can invest the pre-tax equivalent of $775 per month as a salary sacrifice contribution into super. As he earns $90,000 pa, his marginal tax rate is 34.5% (including the 2% Medicare levy), so the pre-tax equivalent is $1,183 per month. This equals to $14,196 pa, and after allowing for the 15% contributions tax, he’ll have 85% of the contribution or $12,067 working for his super in a tax concessional environment.
To work out how much he’ll have in super in 10 years, we’re using the following super assumptions:
- The salary sacrifice contributions, when added to his employer SG contributions, remain within the $27,500 pa concessional cap
- His super is invested in 70% growth/30% defensive assts, returning a gross return of 3.30% pa income (50% franked) and 2.81% pa growth.
- A representative fee of 0.50% pa of assets has been used.
If these assumptions remain the same over the 10-year period, Barry will have an extra $161,216 in super. His outstanding mortgage at that time is $132,662, and after he repays this balance from his super (tax free and he is over 60) he will be $28,554 in front. Of course, the outcome may be different if there are changes in interest rates and super returns in that period.
Get in touch
We can help you decide between mortgage repayments and super contributions on your individual circumstances, life stages, and risk tolerance. Contact us to find the best option for you.
Source: AMP Advant Plus